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Remarks at the New York Bankers Association Financial Services Forum, New York CityAs prepared for delivery

Introduction
Good morning. Thank you for that kind introduction
John. Before I begin, I would like to thank the New York Bankers Association
for organizing this financial services forum and for inviting me to speak to
you today. I really appreciate the opportunity to engage in a dialogue with
all of you. The Federal Reserve Bank of New York has a long history of speaking
at NYBA events and we benefit tremendously from our participation in events
like this.

I should note now that the opinions I express today are my own, and do not
necessarily reflect those of the Federal Reserve Bank of New York or the Federal
Reserve System.

Part I: Taking Stock
Today, I'd like to walk you through some of the modifications in our
approach to bank supervision that we've made in response to the lessons
from the most recent crisis. In order to describe the new era of supervision
to you, though, I believe it's important that we first take stock of
where we've been, and what we've learned, over the last couple
of years.

In a concession to my audience this morning, the title of my speech is "a
new era of bank supervision," but I'm afraid that, in my desire
to be a good guest, I may have been a bit misleading. One of the very first
things we learned during the crisis was that the safety and soundness of the
financial system could no longer be guarded through bank supervision
alone. The reality revealed by the crisis was that systemic risk can also reside
and accumulate in a large and diverse set of financial service providers throughout
the system. Crucially important financial sector participants, regulated and
unregulated alike, were unprepared for the crisis.

This suggests that the new era of supervision must be more inclusive than
the old, more capable of identifying and accounting for systemic risk—wherever
it resides. With the passage of the Dodd-Frank legislation, our supervisors
at the Federal Reserve Bank in New York are now responsible for additional
portfolios of firms. Most importantly, this includes firms designated by the
Financial Stability Oversight Council as "systemically important," or
as a "financial market utility." Our recent name change from the "Bank
Supervision Group" to the "Financial Institution Supervision Group" is
intended to reflect and underscore the broadened scope of the new era supervision.

Not
only did the crisis demonstrate the need to account for a wider array of financial
sector actors than we had previously thought necessary, it also revealed the
growing complexity of individual firms, and the dense interconnectedness linking
them. There certainly wasn't sufficient appreciation of the downside ramifications
of a financial system characterized by such complexity and interconnectedness
until the crisis began. Only then did it become clear that just as complexity
could benefit a firm in good times, it could act as an impediment to disentangling
and unwinding troubled firms in bad times; that just as interconnection could
speed the flow of strong assets in good times, it could make it difficult to
slow or halt the spread of troubled assets in bad times.

Another lesson from the crisis, then, was that the financial system was perhaps too complex, too interconnected,
and its participants too vulnerable to shocks. If the past is not
to be repeated in a new era of supervision, we must find a way to address the
structural characteristics of the financial system that so exacerbated and
inflamed the crisis. We must address the complexity and interconnectedness
of the system. Firms need to be more resistant to shocks and we must demand
more in terms of the quality of management at complex institutions.

Just as
the crisis exposed vulnerabilities in the structure of the financial system,
it also challenged some of our working assumptions within the supervisory community.
As you know, before the crisis our supervisory activities were mainly directed
at testing and critiquing risk management, models and controls at supervised
institutions. We did not spend as much time working to understand firms' business
strategies or key revenue drivers because it was widely believed in the supervisory
community that strong control functions were the primary tool for limiting
risk and ensuring safety and soundness. As a result of our focus on controls,
we were not as familiar as we should have been with some emerging business
risks.

One of the more disturbing realities revealed by the crisis was that
at some troubled firms, those at the top of the house also at times appeared
to have no clear understanding of their firm wide vulnerabilities. In retrospect,
it seems this was often the case because the firm's risk management function
had been marginalized and the risk-reporting chain ignored, or otherwise impaired.
The inability of such firms to quickly and decisively respond to problems was
not necessarily due to significant failings within the risk management function
itself—where our supervisory attention had been focused—but
rather due to the business side's ability to sideline risk managers' concerns
in the interests of greater potential revenue.

Looking back at these episodes,
it is clear that it is insufficient to look at risk management practices in
isolation if we are to fully discharge our supervisory mandate going forward.
The prospect of a marginalized or ineffective risk function requires supervisors
to develop an independent view of revenue-driven risk-taking, and to be capable
of making an informed comparison of risk-taking activity against the firm's
stated risk appetite. In short, the first component of a more holistic, comprehensive
approach to understanding supervised firms in a new era of supervision is an
expanded supervisory focus encompassing business risk and revenue drivers.

The
specter of a marginalized or ineffective risk-management function suggests
that a second component of a more comprehensive approach to supervision is
a better understanding of the relationship between risk managers, business
line decision makers, and top-of-the-house management. To the extent that robust
governance processes would have required business managers to heed risk warnings,
or would have at least ensured that failures to do so were communicated up
the organizational chain, these governance processes are of legitimate interest
to supervisors. While it is impossible to know with certainty how decisions
made up to and during the crisis would have differed had more robust governance
processes been in place, it seems clear that, going forward, an enhanced voice
for risk management will ensure that business decisions are based on a more
complete understanding of risk at the top of the organization.

Part II: Looking Forward
Looking forward, we have to begin by acknowledging that it is impossible to
predict the nature or timing of a future crisis event. This was another take-away
from the financial crisis, and it is precisely why it is vital that we—as
financial institution supervisors and as financial institutions—be
better prepared for the next crisis event, whatever its character, source
or timing.

A new era of supervision begins with asking, "What does a financial
system better prepared to weather all storms look like? What features do
we, as supervisors, think a financial system and its participants need in
order to be considered safe and sound?" I cannot guarantee that we will avoid
another crisis event, but, drawing on the lessons of the crisis that I've
outlined for you today, I can begin to identify features of a financial system
that is more safe and sound than the one we had going into the last crisis.
This financial system, as you may have guessed, is less complex and less
interconnected; more resilient; and, importantly, better managed.

To support
the financial system I envision, we'll need to establish and maintain a deep
understanding of how firms and the financial system are operating; to take
actions to reduce the probability of failures; and to work to lessen the
impact to the public when problems do occur. In practice, this means focusing
our supervisory efforts on three broad areas: (1) reducing the complexity of
firms and the system by making them more recoverable and more resolvable before
problems occur; (2) enhancing the resiliency of firms and the system by ensuring
that strong buffers are in place to prevent potential problems and to increase
the capacity to absorb shocks when problem do happen; and (3) strengthening
the management of firms and the system.

Over the next 12 to 24 months, we will
continue to work toward these objectives by focusing our supervisory activities
on certain key areas. For example, and this list is by no means exhaustive,
to reduce the complexity of the system, we will work with firms to develop
recovery and resolution plans—as
mandated by Dodd-Frank—a process that is in fact already underway. As
you no doubt know, the challenges in dealing with the resolution of financial
firms with large international footprints are numerous, including complex cross-border
legal issues. While the legal issues will take time to sort through,
supervisors across the globe will need to identify ways to collaborate and
communicate in the near-term to make recovery and resolution more possible.

To
enhance the resiliency of firms and the system, we will continue to focus on
ensuring robust levels of capital at supervised firms, as well as focusing
attention on capital planning processes to ensure that firms build appropriate
buffers to withstand a range of stressful conditions in the future. Similarly,
we will continue the work we've begun on liquidity and liquidity risk
management, with an eye to ensuring that firms build sufficient pools of liquidity
to better weather periods of stress and to provide additional time for firms
to consider recovery options.

Finally, to strengthen the management of firms
and the system, we will continue to work with firms to bolster risk management
practices, leveraging our horizontal perspective to identify and promote better
and best practices, and we will expand our supervisory focus to encompass risk
taking activities and broader governance processes.

These objectives—less
complex, more resilient, better managed—apply
to all the firms in our portfolio, including smaller regional and community
banks. This does not mean we are taking a "one size fits all" approach.
That is actually quite contrary to our intention. It does, however, reflect
my belief that it is reasonable for us to expect that each of our firms be
well capitalized, attentively managed, and no more complex than is governable
with the resources at hand.

As I alluded to earlier, achieving these objectives
for our firms and across the financial system will require modifications in
our supervisory approach. In support of these objectives, then, we are going
to work to enhance our knowledge, oversight, and interaction with systemically
important banks and nonbanks, including financial market utilities, and other
supervised firms within our portfolio.

Restructuring our organization and our
supervisory teams to enhance supervision has been a focal point of our efforts
over the past year. In order to understand our firms more holistically—a
key lesson of the crisis—we've
created new positions on our onsite supervisory teams in order to expand our
supervisory focus to encompass front office revenue generation and risk-taking
activity at supervised firms. It is the responsibility of these "business
line specialists" to understand a firm's revenue drivers, business
strategy, and competitive position, and to evaluate the implications of these
activities for a firm's risk profile.

In addition to creating the business
line specialists role, we are elevating the visibility, stature, and seniority
of the leaders in charge of the supervision of the largest firms. Not only
will our "Senior Supervisory Officers" lead
and manage an expanded onsite presence, they will enhance the quality and increase
the frequency of our engagement with senior managers and directors at supervised
firms.

More—not less—engagement with directors and senior
management is indeed a cornerstone of our new approach to supervision, which
is fundamentally meant to give us a deeper view into firms and the risks they
are taking.

By establishing a more intensive supervisory relationship with
those overseeing the health of the firm, we hope to improve the flow of information,
and thus gain an earlier and clearer view into emerging business trends and
risk strategies. Our new approach also supports our goal of better understanding
firms by providing us a richer understanding of firms' corporate governance
processes and weaknesses that, when combined with our cross-firm perspective,
will allow us to come to a nuanced comparative view.

Fundamentally, this approach
is consistent with our need, revealed by the crisis, to better understand our
firms—and for our firms to better understand
themselves. To the extent that we can help firms better understand and
better manage themselves through enhanced engagement, we can bolster what I
consider to be a critical first line of defense.

Part III: Working Towards a More Stable Financial System
In this environment of macroeconomic uncertainty, enhanced engagement—including
enhanced communication and transparency—is more important than ever.
We are committed to applying this approach to our interactions with all stakeholders
in our efforts to understand the common challenges we face in the pursuit of
creating a more stable financial system.

The challenges are many. As was reinforced
by regional and community bankers on an upstate visit earlier in the year,
consumer confidence remains mixed, and consumer lending is still weak. Housing
prices are flat in some areas, and continuing to decline in others. Reports
on small business lending and construction are also mixed. In some cases, the
demand for loans simply hasn't picked up; in others, it's difficult to find
borrowers, battered by the recession, who meet underwriting standards. And
that's just the regional economy—I haven't even mentioned the uncertainty
associated with regulatory reform; the slow pace of the national recovery;
and, the effects on our economy of developments abroad.

In addition to the
Upstate and other district-wide visits, which allow us to hear from, among
others, regional and community bankers in their own backyards, we're working
to create additional venues where you can share your views on the issues that
most concern you.

At our largest and most complex institutions, that point
of contact is our Senior Supervisory Officer. At our regional and community
banks, we're creating forums, like the Community Depository Institution Advisory
Council, where our community bankers can provide us with information, ideas,
and suggestions on a wide range of topics—from local community issues
to regional economic issues to the impact of national policies.

This information
helps to better inform us as we work to ensure safety and soundness in the
financial system, while at the same time appropriately adapt our approaches
and focus to reflect the challenges facing the broad range of institutions
we supervise.

Conclusion
To summarize, if we are to produce a "new era of supervision" in
the future, we absolutely must begin by applying the lessons of the past. These
lessons, which pertain both to the structure of the financial system and the
methods we use to supervise, point towards a financial system that is more
resilient, less complex, and better managed, and a supervisory method that
takes a more macroprudential view and is deeply engaged with firms.

If there's
any unifying theme to this I think it has to be the need for balance. Whatever
the new era of supervision ultimately looks like, it cannot be considered successful
unless it produces an environment that allows supervised firms to grow and
flourish in a way that is consistent with the broad public good. I hope you've
found the new era of supervision that I've described to you today compelling,
and I look forward to working with you and your institutions towards a safe,
sound, and accessible financial sector that also contributes to the health,
vitality, and dynamic growth of the real economy.